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October 2011

October 30, 2011

I like reading a good web site post, but what I really like is finding an excellent, on-going source of information. If you are really interested in energy investing, the investor village BRY board is such a place. I don't have time to really follow it, but if I were serious about energy investing I would. Here's the thread where I asked them what to investigate at the ASPO USA Peak Oil conference this week (click here). My inquiry provoked a discussion of how the Tight-Shale Unconventional Oil affects Peak Oil. What follows is, in my view, the two top posts:

The entire statistical basis for Peak Oil fell apart in 2005-2008. Peak Oil was based on a statistical analysis of conventional reservoirs that have been or would be discovered and production projected, based on the hypothesis that oil was a finite resource that was limited to those conventional reservoirs. The two events that started to cause the statistical basis to erode was the extension of exploration to deepwater, which could be argued is fairly minor due to the expense and techological challege, which is true. The event that really shot Peak OIl apart was the application of horizontal drilling and multi-stage fracturing to unconventional reservoirs, first limited to natural gas in the Barnett and now spreading to many shale plays worldwide, which include both liguid-rich natural gas and outright oil.

The volume of conventional reservoirs that could produce is limited by the combination of the need for the source rock, reservoir rock, and a seal, which is limited to relatively small amount of the earth's crust. However, the so-called shale plays are much more extensive, dwarfing the conventional reservoirs volumes. A good analogy maybe an elephant to a gnat, on a rock volume basis. True, not everything will be productive, and there will be ranges in economics, which can now be estimated for the variety of shale plays.

In short, the entire basis for Peak Oil was eroded with the emergence of the shale plays - and no one in their right mind would claim the Hubbert conceived of them in his original model. At $3.00 oil, the shale plays don't work, but we are not at $3.00 oil and the shale plays work very well, and will work even better as the technology improves.

The shale plays are one of the most transformative series of events in the world's energy history, and like the advent of the internet, they will change everything.

The shale plays basically prove that the economists were always right:

Don't tell me we have a shortage. Tell me "at what price" we have a shortage.

That obviously applies to oil demand (at $100 world demand is 89 MBPD, at $60 it would be higher and at $200 it would be lower)

It now applies to oil supply...although the curve is not linear, and the curve is steep at our current equilibrium.

"The curve is steep" means that it takes significant oil price increases to increase the supply (because of all the depletion we are running against). Its not vertical as the hard core Peak oil people would maintain (IE - even if oil was $300 a barrel we would not be able to increase the world's oil production---NO CHANGE in oil price is high enough to cause an increase in supply)

The curve is not linear means that there are certain "price steps" at which significant supply growth stops. The breakeven price of new offshore drilling is one, the breakeven price of new oilsands expansion is another, the breakeven price of oil in unconventional resevoirs, albeit quite low, is another...and of course the breakeven budget prices of Saudi Arabia and other Middle East states should probably be considered another, perhaps the highest price point of them all).

Anyone talking about Peak Oil being "the end of days", and going back to farming with a horse and plow because we don't have enough oil to run the tractors, well, they've been proven resoundingly wrong, and should sound like shrill doomsdayers to most educated people now. The tractors may run on Natural gas, or they may run on Eagleford/Bakken/Cardium/Oil sands oil, but they will run, and in greater numbers than ever as we feed a booming world population. 7 Billion strong, and growing.

"

Let me know what you think, especially about "the end of days" comment.

October 29, 2011

For me the big interventional this week is: "Bernanke Speaks" following the FOMC meeting on Wednesday. I expect I'll close my short term long-gold options trade a little earlier than planned (Wed close). They can't allow the price of gold to make Bernanke or the Federal Reserve look like money printers.

This web site regularly posts a nice roundup of the next week's economic announcements: Calculated Risk

Havey Organ has a great column today (click here) although you might want to skip down to where his survey of Europe Debt Crisis Deal reviews starts. Here's a few of the money quotes (most from this one report from The Economic Collapse:

"people have begun to closely examine the details of the European debt deal, they have started to realize that this "debt deal" is really just a "managed" Greek debt default."

"But investors are not stupid. Greece was allowed to default. If Italy or Spain or Portugal gets into serious trouble it is likely that they will be allowed to default too."

"The big message that Europe is sending to investors is that when individual nations get into debt trouble they will be allowed to default and investors will be forced to take huge haircuts. As this reality starts to dawn on investors, they are going to start demanding much higher returns on European bonds. In fact, we are already starting to see this happen. The yield on two year Spanish bonds increased by more than 6 percent today. The yield on two year Italian bonds increased by more than 7 percent today. So what are nations such as Italy, Spain, Portugal and Ireland going to do when it costs them much more to borrow money?"

Here's the link to the speakers list(click here). Leave me a reply if there's anyone in particular you want me to ask a question of. I'm pretty convinced that Peak Oil is real and significant, but have not:

Found any way to trade it for excess profit OR

Made any significant lifestyle adjustments other than buying a prius and buying a suburban home w/natural gas heat closer to key infrastructure.

Here's the chart I'm going to present as a conversation starter:

I got hip to Peak Oil too late to benefit from that really juicy run-up from 1999 thru mid-2008. Since then, Peak Oil doesn't seem to have provided a mechanism for excess returns. My questions are:

If Peak Oil is real, why hasn't it been providing excess returns lately - probably because the price of oil keeps crashing the world economy, but I'd like to hear the thoughts of others.

When will Peak Oil start providing excess returns and what industries will it show up in?

Long crude oil (near-term futures or long-term, e.g. 2016 futures)?

Long oil producers with significant reserves in politically safe places?

Will this North Dakota, tight-oil fracing production and technology (and potential follow-ons) change the Peak Oil timetable or the energy outlook for the USA significantly?

Again, let me know if there are any particular questions you want me to check out or people you want to ask a question of. Last year I got a quite nice tip from Charles Maxwell regarding going long Cenovus (CVE). I made a little money on that in my mother's account. If I had stuck with it I would have done better.

I will probably be lugging a laptop to the conference and posting live therefrom (in a pretty crude fashion). That would be from Thurs thru Saturday morning this week.

October 28, 2011

This Fidelity Investments advertisement (masquerading as a news story) reminds me of the twilight zone. But first let me paraphrase: "You should stop trying to beat the market and instead be a sucker putting your savings where we (along with the rest of the financial industry) can siphon off an annual percentage".

As you will recall, the book entitled "To Serve Man" was a cookbook. One of the first and most important lessons of investing is: "THEY (the mainstream financial press and its advertisers, in fact all those large-cap financial corporations) are not your friends. At best, they are there to get a percentage of every transaction. Usually they are there to take an unfair advantage of the retail investor."

October 23, 2011

I had the morning off from church this week taking care of the 10 year old with a cold. That explains all of the posts. For the first time in a week I've had a chance to consider the markets with some intensity.

Here's my findings:

Overall Impression - I'm feeling quite bamboozled at this point. My general modus-operandi is to do nothing when confused with potentially really bad results. This time I'm going to lighten substantially on some of everything if things don't get clearer to me soon.

Macro Buzz - This buzz is from reading the news. It says either:

the Europeans come up with a plausible plan and the risk on inflationary trade is on (Dollar down, US Stocks Up, Commodities Up, Gold Up [but not as much as stocks), Silver up. OR

I guess we'll hear something tonight. I expect an overnight pop thru the morning as they'll definitely have some kind of semi-positive sounding news, but that the deflation trade will show up by the New York close if they aren't close to a plausible plan. I think all this Euro Crisis Macro buzz stuff is obvious to anyone paying attention to the markets. I also think it takes a continuous stream of bad news to keep the fear trade going. No news is good news which pretty much accounts for the recent "risk on" trading action.

There's also very quietly some bearish noise coming out of China which I think is responsible for Copper and other commodity weakness beyond what is expected from the Euro Crisis stuff. This is not fully taken into account by financial press or average money manager. If we get a relief rally, I don't expect commodities to lead.

Now based on the charts, here's what I see:

US stocks broke above their recent trading range but there's stiff resistance within a couple of percentage points. What happens short term depends on the European situation. A move thru the remaining resistance at S&P $1260 is bullish and it will be time to abandon any bearish stock positions.

Emerging markets are flat out trending down and ugly. I think this is related to the China macro buzz. They are dragging commodities with them.

Everything seems to trade around the US dollar which seems to be weakening.

The recent collapse in 30-year US treasury yields (and now their rapid recovery) is signaling that the Euro situation will blow over (I think).

Gold looks ok as long as the 150 day moving average holds. The commitment of trade report is bullish.

Silver's chart looks like a bear flag to me. A breakdown under $30 that holds signals another big silver price collapse. I don't buy the Eric Sprott story, yet.

By the end of this week the European situation should be clearer and I expect either to have eliminated my S&P 500 put options hedges or will have lightened up on the gold futures options and cut my core gold stock positions.

Perhaps I'll supplement this post tonight with with some charts, time permitting.

Let's put in just about the longest average of the $GOLD:$SILVER ratio that www.stockcharts.com will print: 360 months == 30 years. As you can see, the ratio is lower than the average. So, gold is cheap relative to silver from a 30 year perspective (although not as cheap as in April 2011). You get the same results if you put in a 20 or 10 year average.

Seems like I heard something quite different from Eric Sprott recently. Tell me again what his data was to backup the idea that silver is undervalued relative to gold? It sounded great at the time.

There is one interesting thing to report from Friday's trading. I'm currently holding a bunch of S&P 500 $1300 Dec 16, 2011 put options as a hedge against deflation taking gold down with everything else.

That's what derivatives are for right? To limit risk.

Well, with the S&P 500 closing on its high Friday in what I consider a "What Will They Come Up With Over The Weekend?" short-covering rally, I decided to lighten up on those put options. Now, these put options are in the money. They have intrinsic value.

Looking at my screen I saw: No Bid for those put options. Let me be clear: Nobody was willing to put up any kind of price (even much less than their intrinsic value) for even one of those put options.

I should have gotten a screen capture for you, dear reader, but the thought did not occur to me.

I considered S&P 500 put options to be pretty liquid, that is, that I could sell them if I wanted to, even under pretty extreme circumstances. Wrong.

That's the problem with "Mark To Market" accounting, you need to have a "bid" under the item to know what its market value is. If seemingly ordinary, short-term, in-the-money S&P 500 put options go no-bid under pretty much ordinary market conditions (the S&P 500 was only up 2%), then just imagine how hard it is to get the market value for all the crazy stuff the "too-big to fail" banks trade:

In addition to counter-party risk (where the other party may default and so a paper asset loses some or all of its value), there is "no bid" risk, where you can't find somebody to buy your asset (at any price) when you suddenly need to. At this point I have to conclude that when "The big one" comes, everything is going to go "No Bid", at least temporarily. The May 2010 "Flash Crash" was not even close to "the big one" and yet all kinds of seemingly substantial assets (large-cap stocks and bonds) went no-bid. When the big one comes the banks and markets will be closed. Remember, the markets closed for a week after 9/11 and were closed for months during the outbreak of WWI.

Here's a definition for a "safe haven asset": An asset that can be held for months providing a precise amount of "buying power" at any time under just about any circumstance.

The recent 20%+ rapid rise (and drop) in the price of gold demonstrates that it is not that perfect as a safe haven: It doesn't provide a "precise" amount of buying time over months.

Physical gold, owned with clear title and stored in a safe, accessible location, is a safe haven if you relax the defintion to: substantial "buying power"... This is because gold, thus held, has:

No counter party risk AND

Lower "no bid" risk than just about anything. I expect that even during "the big one" that physical gold will still have purchasing power.

Based on what I've learned, the questions I have to ask myself at this point are:

How much of my savings do I want to keep out of the banking system in actual Federal Reserve Notes (Franklins) against a temporary bank/market closure. The answer is probably enough to get by for a couple of weeks, but not more because "THEY" typically close the banks so "THEY" can revalue down the currency.

How much of my savings do I want to keep in assets other than "physical gold safely and accessibly stored"? At this point the answer is: enough to provide a way of increasing wealth in the face of "financial repression" that is government taxes and government manipulated low interest rates and high inflation. I want to have more than enough to share. On the other hand I want enough in physical gold safely and accessibly stored to make it through "the big one". The amount of physical I want is increasing as the relative risk of the "big one" coming soon seems to be rising.

There should be quite a flow of money into physical gold as the desire for this kind of safe-haven increases. Its quite bullish for the price of gold, I think.

October 16, 2011

Here's my tour throught "the usual charts" highlighting the charts that make me ask questions. They seem to all revolve around the fundamental question: Has the European sovereign debt crisis been contained or are we in the lull before the storm? Leave me a comment if you have any answers.

Banking stocks have been consistently lagging the general stock market for a while. I watch this ratio because banking stocks are a leading indicator for the general stock market according to Gary Biiwii and others. Can this trend continue and is it too late to trade with a long/short strategy? If nothing else, I think a sustained piercing of the 50-day moving average will probably indicate that the bottom is in for banking stocks and that tradable entry point has arrived.

I've been accumulating Dec 2011 S&P 500 $1300 put options because there's a good chance the current relief rally is about spent and because options seem to be a lot cheaper when the underlying short-term trend is still against them. At what point should I throw in the towel and take a loss if the general stock market keeps rising? When the resistance around that 50% fibonacci and 50 day moving average is taken out and held over a weekend thru a Monday?

The above, way too busy, weekly chart shows the $SPX about to run into a tonne of resistance. Once again, can it fight thru and what criteria (price, time, volume, etc) for broken resistance should I use?

I've been watching the 30-year treasury yield hoping it will give a good signal when the panic stock market selling has concluded (click here for the full analysis). We nearly got a "go long" the stock market signal last week. Should I have reversed my S&P 500 puts position and gone long assuming that the entry criteria were met well enough? In 2008 jumping the gun would have started the trade out with an unsustainable draw-down even though it ultimately would have proved profitable.

Here's another look at long-term treasury yields. Looks like a lot of money is to be made going short. I wonder how expensive TLT puts are?

The US dollar has consistently been moving in the opposite direction of the general stock market (and many other markets), has stopped its rapid rise and retraced 50% of its rise and is at resistance? Will it bounce or will it fall and will it continue to push the S&P 500 in the opposite direction?

FWIW, the monthly US dollar chart looks pretty bearish to me being unable to stay across that trend line.

China took a week off from cratering. Shorting this was certainly a lost opportunity. Will its recovery continue next week? How can the S&P 500 diverge if it can't?

Copper's weekly RSI says the bottom may be in. Time to buy some futures or futures options? Use recent lows as a stop.

So far, so good with the analysis of whether gold has bottomed (click here). I expect it has, but like most of the charts shown so far it depends on this question: Has the European debt crisis been contained or is it going to trigger another, bigger panic? If its contained then I expect the bottom is in for many markets and were ready for a multi-month rally. If not we should have another major leg down in everything, I expect. Until I get a little more clarity, I expect I'll hold my S&P 500 puts even if the S&P 500 moves a bit higher.

You may have noticed that I'm not posting that often. This is because:

I don't have much to say that I'm not reading in other bigger, out-of-the-mainstream news sources (Jesse, Harvey, King World News, Dave From Denver, ...).

I've had my head down working til my eyes bleed on my basically a hobby day job. I'm in the rare position of nearly single-handedly coming up with a technical innovation and new product that is the best hope of giving a struggling three-hundred job division a competitive edge. Its amazing fun except when I over-do it.

FWIW, I'm holding $1500 Dec 12 gold futures call options, PHYS and $1300 S&P 500 Dec 11 puts in my trading account, a bunch of PHYS and my core gold miners in my investing account and some gold and silver offshore with GoldMoney.com. I'm not so sure about the S&P 500 puts. Not including taxes I'm up around 20% year-to-date.

October 03, 2011

It turns out there's a big interventional coming up tomorrow: Bernanke Testifies before a hostile US congress.

Add in that the S&P 500 chart is breaking down.

Add in that my own internal emotional meter is on real fear for the general stock market and US economy even though I don't own US stocks and my day-job (which I don't really need) is secure.

Together I conclude the risk/reward is good for a small, short-term trade betting THEY can push the US stock market up. I just went long ES Dec futures with a nominal value of about 10% of total portfoio value at $1087.75. Will unload around when Bernanke ends his testimony tomorrow. If the move is up strong then I'll hold until near tomorrow's close. Look for an update (for better or worse) after I exit.

This kind of trade would make a lot more sense if it were back-tested. I guess its time to start gathering data for "Bernanke Testifies" days.

Even my expensive news letter (name intentionally withheld), which has been coyishly bearish on gold for a while, sent out an update suggesting the bottom was in or nearly in.

As an aside, I believe my take on the interventionals for this week were pretty accurate (click here). The main interventional coming up for this week is Friday's unemployment report. My analysis of unemployment reports is that the interventions are typically just intra-day.

So, I come to the questions:

Is the gold bottom really in? If not how much further has it to go?

Whether the bottom is in or not, what can we expect looking out a little more than a year to Thanksgiving 2012.

Most of this piece is based on the idea that this correction was special in that the vertical dive was a liquidity event where all markets were falling at the same time and gold was sold to take profits and to protect against margin calls in underwater positions. Specifically, the gold vertical dive took place at the same time that the S&P 500 was falling hard. My piece from last week (click here) introduced the concept, identified the four previous occasions in the last decade where this happened and analyzed those occasions.

Gold formed something that looks like a head and shoulders pattern (light blue) and achieved (briefly) that the target low.

Gold fell hard (while the S&P 500 was falling hard, see blue box).

There is lateral support (gray lines) associated with price levels preceding the accelerated rise.

Gold has fallen back and gotten support at the first level of lateral support with a brief almost touch to the next level of lateral support. Further support lies around $1575, $1560 and $1475.

If you look at every case over the last decade of a correction from a bull-market high thru the 50-day SMA (click here), you'll see that gold always falls back to the lateral support associated with the take-off point to the rise to the all time high. I should have been expecting this, but was too optimistic. Gold has fallen back to the first lateral support, but looks (based on prior bull-market high corrections) like it could easily fall to the $1550 level. That's another 5%.

The table that follows compares the current correction with those corrections where weekly closing prices are used. Rows 2..4 look at the previous such corrections. Rows 5..8 look at different scenarios associated with the current correction. The correction in 2008 is bigger than the others and has the notable feature that there were two consecutive liquidity events (one in Sep 08, the 2nd in Oct 08). The table that follows treats those two events as a single event.

The current correction has a weekly decline from the near-term top to the bottom (so far) of 13.7%. The Feb 07 correction was shorter (D2) and smaller (F2). The 08 double event was both deeper (F3) and longer (D3). The 09 event was quite comparable in depth (F4) but longer in duration (D4). Still it is the most like the current event (so far). The data examined so far leaves me less than really confident that current correction's bottom is in.

Rows 5..8 give various scenarios regarding how the current correction might work out.

Row 5 assumes, as the above pundits have predicted, that the bottom is in and that the resulting rise to mid-November 2012 is similar to the rise from the Feb 07 correction to Nov 07. The bottom is thus $1626 and the price mid-Nov 12 is estimated at $2,084 for a 28% rise.

Row 6 assumes the bottom is in (like Row 5), but that the rise to mid-Nov 12 is between the rises out of 07 and 08 and proportional to the decline relative to the 07 and 08 declines. That provides an estimate for mid-Nov 12 of $2594 or 40.4%.

Row 7 assumes the bottom is in (like Row 5), but that the rise to mid-Nov 12 is the same as the rise out of the 09 event (30%) producing a target price of $2114.

Row 8 assumes that the bottom is not in and that the decline will be as deep as the 08 decline (25.3%) targeting a bottom of $1408. With the same rise out of the bottom as 08 (59.5%) the estimated mid-Nov 12 target prices is $2246. I don't expect the current fall to go as far as the 08 fall, but I find this scenario useful as a weekly close below that $1408 price can be used as an indicator that something is different and perhaps the gold bull run is over. I expect that row 8 would only occur if another liqudity type vertical fall began. A simultaneous hard fall in the S&P 500 and gold might indicate a trigger, going forward, to liquidate leveraged positions.

In conclusion, I find:

There is some reason to think the liquidity-related correction is gold may not be over. Specifically, in 08 the drop was larger (with dual liquidity events) and gold has not really corrected all the way down to previous highs.

The support of $1560, $1510 and $1475 seem like good targets for the correction low if it is not yet in.

There is some reason to think the liquidity-related correction is over (the decline exceeds 07's and matches 09's, the decline has reached pre-accelerated rise support and the experts says its over).

Most importantly there is good reason to think that the price a little more than a year out will be significantly higher than the current price ($2114 seems like a good target).

As a result of this kind of analysis, I closed all my Dec 2011 gold options (for huge losses) because they were so far out of the money that they threatened to "go to zero". I then put the money (and some cash raised from a sale of PHYS) into $1500 Dec 2012 options. My overall portfolio leverage is now a little less than 2 to 1.

As far as risk management goes, there's that $1400 stop (see above) and the exit on a renewed liquidity drops. As far as black-swan risk management goes, I still have enough bullion (GoldMoney and PHYS plus some coins in a safe-deposit box) to retire comfortably (but without much margin) even if another big gold correction comes wiping out those Dec 2012 options and decimating my gold mining stocks. I think my risk tolerance remains higher than most but that risk is being managed.

The lessons I've learned from this correction so far are:

If a correction starts and I'm ill I should admit I don't have the mental horse power to really trade the situation and get out of leveraged positions.

Expect a correction from a bull market high that breaksdown thru the 50-day SMA to continue to fall to the luanch point of the rise to the bull market high. Dump all leverage as soon as the correction starts.

Be better prepared through the life of a trade as far as what to expect should a trade go against me so that I don't have to analyze the situation from scratch as the correction takes place.